There are numerous trading strategies and most of them rely on completely different variables when forecasting market prices, but none of them stand out as being “the best”. Anyone who dares to say that one strategy is better than all the others is still a beginner in the forex trading world. Each strategy is designed to work for a specific market condition or even a particular currency pair. In today’s volatile market, perhaps the best strategy for successful trading is mean reversion.
Simply put, buy when low, sell when high, and do it before the shift in the price direction actually occurs. Mean reversion trading is by far the most popular trading style in the world, but does it work? Some traders use mean reversion exclusively, and they often do better than other strategy traders during market volatility.
Mean reversion takes advantage of rapid price changes, which are commonly followed by a reversion to the average or mean. It is a mathematical strategy that applies well to currency and stock trading. It works on the premise that every trading asset, high or low, is just in a temporary price extreme. The high or low cannot last, and it will revert closer to the average price over time. Followers of the mean reversion strategy are always expecting the trend to end.
The first thing a mean reversion trader will do is select a specific currency pair and figure out the average price. Be sure to consider all trading ranges available from long-term to short-term.
Mean reversion takes the guesswork out of trading. Guessing is what newbie traders do in the first few months of their career, and more often than not they lose everything, including faith in their forex trading abilities.
Whenever a currency pair price is holding below the average price, a mean reversion trader takes this event as an indicator for a ‘Buy’ order. A mean reversion forecast suggests that the price must eventually rise to become mathematically balanced. Alternatively, when the market price is above the pair’s average, it tends to revert or fall back to the mean. So just how can a trader recognize when to trade?
Traders often use moving averages to define parameters that trigger an action. A good benchmark is to first set the moving averages at 50 and/or 100 days to first see if the price shift has already overshot the mean. You can even measure the highs and lows manually in order to create an average, although the MT4 Indicator will do a much more accurate job.
Using mean reversion to target currency pairs is great for short-term trades that present during highly volatile market conditions. Using mean reversion with long-term trades typically ends disappointingly. It is ideal for short-term trades that last no more than minutes or hours.
When using the mean reversion strategy, avoid price charts that show valleys and plateaus. These long dips are not typically found on a price chart and will easily stand out. The presence of long dips and plateaus on a price chart could indicate that the price won’t revert back to the mean any time soon.
Mean reversion is best suited to traders willing to take on high risk for high profit. It’s also favorable for currency pairs that have been recently oversold.
To make the most out of mean reversion, a trader needs to switch off all emotional influences. It can be scary sometimes as mean reversion trading typically targets short-term trades that carry higher risk, but those trades can make money quickly.
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